CFTC Commission Rostin Behnan is the chair of this committee and in his opening statement he made this announcement about a new sub-committee and its new chair.

“Today’s agenda begins with Tom Wipf, Vice Chairman of Institutional Securities at Morgan Stanley and our newly appointed Chairman of the Interest Rate Benchmark Reform Subcommittee. Tom has more than forty years of experience as an industry leader and has served in multiple capacities at Morgan Stanley in New York, London, and Tokyo.” Behan stated in his opening remarks.“Over the years, he has held several key roles at the U.S. Treasury, the Federal Reserve Bank of New York, and currently serves as a member of the Alternative Reference Rates Committee (‘ARRC’) of the Board of Governors of the Federal Reserve System (‘Federal Reserve Board’), which will be particularly relevant to his role as the Subcommittee Chairman.

“The last meeting of the MRAC in July introduced benchmark reform as a key topic of interest not only to MRAC members, but also to anyone who has a car or small business loan, student loan, mortgage, or credit card. As highlighted by Chairman Giancarlo in remarks last week at the 2018 Financial Stability Conference, despite huge improvements in the governance process to produce LIBOR, the market for unsecured inter-bank term lending that underlies LIBOR has dried up, and the regulatory mandate compelling LIBOR submissions has an expiration date. Fortunately, there are coordinated initiatives underway specifically targeted at addressing the myriad of impending issues specifically related to the derivatives market. Chief among these initiatives is the ARRC, which is tasked with leading and directing the transition away from LIBOR to SOFR, the Secured Overnight Financing Rate.”

Tom Wipf, Vice Chairman of Institutional Securities at Morgan Stanley

The SOFR, or secured overnight financing rate, was created by the ARRC, or Alternative Rate Reform Committee, which was created after the LIBOR trade fixing scandal.

The SOFR was supposed to compete and hopefully replace LIBOR as a market driven overnight rate.

The entire meeting was approximately six hours long and The Industry Spread will follow up on clearinghouse risk management in an upcoming article; for now, the meeting was another who’s who of industry heavyweights.

Since the financial crisis of 2008, the number of Futures Commission Merchants (FCM) has decreased significantly, and the Commodities Futures Trading Commission has taken notice.

“The statistics paint a very concerning picture. For futures, the number of FCMs has declined from 100 CFTC-registered entities in 2002 to 54 as of August 2018, with the top five and ten FCMs holding 54% and 73% of total client margin, respectively. For swaps, the client clearing landscape is concentrated further to less than 20 FCMs. Only 17 FCMs are holding client margin for swaps clearing with the top five and ten FCMs holding 77% and 98%, respectively. Further, the Consultation Report prepared by the Financial Stability Board’s Derivatives Assessment Team (DAT) on incentives to centrally clear OTC derivatives appears to be consistent with these findings.” Said CFTC Commissioner Rostin Behnan, in a speech in Chicago.

The speech was made on Tuesday, October 16, 2018, and entitled “A Decade After the Financial Crisis: Remaining Challenges and New Approaches for the Next Ten Years and Beyond.”

An FCM “plays an essential role in enabling customers to participate in the futures markets. An FCM is an individual or organization involved in the solicitation or acceptance of buy or sell orders for futures or options on futures in exchange for payment of money (commission) or other assets from customers. An FCM also has the responsibility of collecting margin from customers.” The website Investopedia stated.

Walt Lukken is the Chief Executive Officer of the Futures Industry Association and he was the most recent guest on the podcast of Andrew Busch, where he made a similar point about the reduction of FCM’s.

“We’ve seen a shrinkage in the clearing member community that serves as the foundation for the clearing system. Before we had over 77 today we’re at 54.” Lukken said when he appeared with Busch on Busch’s podcast on Friday, October 11, 2018.

Busch is CFTC’s Chief of Market Intelligence.

This was not the first time Lukken had spoken about clearing shrinkage; he made the same point in a speech in March 2018.

Indeed, the reduced number of FCM’s was one of three “unintended consequences of solving yesterday’s problems” as Lukken stated.

The other two were less funding of technology and less cross-border trading.

Why Are FCM’s Shrinking?

Both Lukken and Behnan had theories for why FCM’s have shrunk.

“Many large bank-owned FCMs have exited the swaps clearing business citing as one reason the global introduction of the Basel Committee on Bank Supervision’s Basel III leverage ratio and the Supplementary Leverage Ratio (SLR) in the United States. The SLR, a bank-based capital charge designed, in part, to reduce risk posed by on-balance-sheet lending activities, has been applied to centrally cleared derivatives.” Behnan said in his speech.“The adoption of swaps clearing moved segregated client initial margin off the balance sheets of clearing member FCMs and into CCPs. However, the SLR treats customer margin as an on balance sheet asset.

“The global implementation of the central clearing mandate has produced a significant demand for clearing services and a substantial increase in overall clearing volumes in the swaps market, and yet there have been FCM consolidations and market exits, which have resulted in a substantial reduction in clearing capacity. Given that central clearing is a key component of the G-20’s effort to improve derivatives markets, policymakers, both bank and market regulators, must take the necessary steps to ensure that client clearing remains a commercially viable business. However, according to the DAT Consultation Report, 89% of client clearing service providers surveyed said that the leverage ratio, in particular, was negatively impacting their ability to provide client clearing services.”

“The shrinkage of FCM’s has been a pretty public problem that we’ve tried to highlight at FIA,” Lukken said on Busch’s podcast. “One of the issues have been that we are becoming a more automated, standardized business. So, there are some structural things beyond regulations. Some of it on the margins are high barriers to entry that are causing from either a regulatory stand point or a capital stand point that are causing shrinking FCM community.”

Of SLR- which Behnan also mentioned- Lukken said, “We’ve been working with the CFTC and prudential regulators on trying to address the leverage ratio, which mis-measures the risk that FCM’s bring to a bank.”

The SLR and FCMs

The supplementary leverage ratio (SLR) is yet another invention in response to the 2008 financial crisis.

As Behnan noted, “The SLR, a bank-based capital charge designed, in part, to reduce risk posed by on-balance-sheet lending activities, has been applied to centrally cleared derivatives. The adoption of swaps clearing moved segregated client initial margin off the balance sheets of clearing member FCMs and into CCPs. However, the SLR treats customer margin as an on balance sheet asset.”

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